Credit default swap (CDS) transactions or “CDS trades” typically refer to contracts between two “counterparties” wherein a first counterparty (i.e., a CDS buyer) makes one or more periodic payments to a second counterparty (i.e., a CDS seller) in exchange for payment by the second counterparty to the first counterparty if an underlying financial instrument defaults. The underlying financial instrument and its associated entity may be referred to as the “reference entity” or in general as the “obligation.” From a certain perspective, CDS transactions resemble an insurance contract in that the payments from the CDS buyer to the CDS seller may be thought of as “premium payments” that are made in return for a presumably large payment upon the occurrence of an event, namely if a specified financial instrument fails. In many instances, the underlying financial instrument is a bond or a loan, however, other instruments may be used. However, unlike typical insurance, the CDS buyer need not own the underlying financial instrument.
However, as the number and complexity of CDS transactions increase, concerns arise as to several aspects of the current system for managing and monitoring these type of transactions. For instance, three or more parties engaged in multiple CDS transactions may create circuitous obligations and positions. In other instances, the large volume of CDS transactions may obscure the exact position and exposure of various market participants. In many instances, the exact exposure of parties to a CDS transaction (i.e., who owns what products and what the net exposures are) is known only on a bilateral basis (i.e., to the two participants to that transaction). This may form a tangled web of positions and exposures that may endanger the market as whole. In some instances, delays in the affirmation and confirmation of the existence of CDS transactions also contribute to the lack of information in the marketplace as a whole.
Many other concerns relating to imperfect information among market participants may exist. For instance, the occurrence of credit events relating to reference entities such as, for example, bankruptcy, failure to pay, restructuring, repudiation, moratorium, credit downgrades, or other credit event may affect payment responsibilities of counterparties to a CDS transaction. However, the determination of when a credit event has occurred is often left to the CDS buyer. Thus, from a perspective outside the specific CDS transaction, it can be difficult to determine when a credit event has occurred.
In some instances, clearinghouse entities may exist to mediate and/or assist with certain of a CDS transaction. However, these clearinghouses, inter alia, may not provide adequate and timely information to the market as it relates to pricing individual counterparty exposure and systemic risk.
These and other problems exist.